Have Low-Volatility ETFs Overstayed Their Welcome?

Asset Class ETFs News:

We’ve written extensively about the popularity and outperformance of low-volatility ETFs in a market that favors defensive sectors, but how much longer can the party last?

For example, PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) have together gathered $9 billion in assets in less than two years since they launched, according to Morningstar.

The low-vol ETFs are also outperforming the market as measured by the S&P 500 this year with conservative sectors such as utilities, consumer staples and healthcare leading the way.

However, investors who have recently piled into low-volatility ETFs may end up disappointed if there is a sector rotation away from defense and cyclical sectors start pacing the market.

“The rally is not about low-vol, it’s about value stocks and dividends versus growth stocks and cyclicality,” says Josh Brown at the Reformed Broker blog.

“This year, there’s something new happening, where nongrowth stocks are being pushed up toward growth multiples because of their ability to substitute for expensive bonds and return lots of cash,” Brown told IndexUniverse.

After being overweight in defensive, value stocks for two years, he says he’s now far more interested in cyclicals, which are hated.

“Once the market gets bored of paying 20 times earnings for candy companies and utilities, we’ll be waiting for the rotation,” Brown added.

So low-volatility ETFs have been very popular with investors so risk-averse after the financial crisis, and the strategy has outperformed. The question is how much longer the trend can continue.